What Really Caused the Great Recession of 2008?

You’ll find plenty of blame to go around on this subject, but a little study shows that there were four or five major factors that caused the last big recession, and neither a single president or a single party can be blamed.

First, the expanded mandate of Fannie and Freddie - The housing collapse can be traced back the Clinton administration’s pressuring of Fannie and Freddie to encourage more home buying. The Community Reinvestment Act — in which banks were encouraged to lend to people who normally would not be worthy of obtaining home loans — was especially pernicious. The Act had been around for a long time prior to Clinton, but the Clinton Administration turned a once-obscure and lightly enforced banking regulation law into one of the most powerful mandates shaping American cities. This actually started way back in the Carter administration.

Second, The FED kept interest rates too low for too long. Keeping interest rates artificially low led predictably to excessive credit and speculative asset bubbles — such as occurred in the housing market, which was the bubble that brought everything down. It wasn’t Wall Street at all – they were just doing what they normally do. What happened is that Fannie and Freddie badly misrepresented the soundness of the loans that Wall Street was securitizing.

Third, mark-to-market accounting, which requires financial institutions to adjust their balance sheets and capital accounts whenever the value of an asset they own increases or decreases. The trouble with this is that it requires banks to show paper losses for assets they may have no plans to sell. FDR suspended mark to market accounting in 1938, but unfortunately, the George W. Bush administration brought it back in 2007.  Of the more than $700 billion that financial institutions have written off, almost all of it has been book write-downs, not actual cash losses.

Fourth, repeal of the uptick rule – enacted by FDR, the uptick rule says investors can’t short a stock unless it goes up in price.  In 2007, the SEC got rid of the rule, resulting in investors betting against the market, manipulating the market, and depressing stock prices.  I should add that many dispute this, but the fact remains that it had an effect.

Fifth, Repeal of Glass-Steagall – A main provision of Glass-Steagall was separating investment banking from commercial banking. But in 1999, the Gramm–Leach–Bliley Act (passed by a majority of Republicans and signed by Bill Clinton) repealed that provision. The problem is that this encouraged banks to be speculative — to take risks, knowing all along that the FDIC would insure their loss. 

This list focuses on things where government was responsible in one way or another. But it’s also worth noting that the creation and rapid expansion of new financial instruments (credit default obligations and credit default swaps) certainly contributed to the financial crisis. These problems were collectively created in a bipartisan fashion — with mistakes being pretty evenly divided between the Clinton and Bush administrations. Most of the primary contributors to the Great Recession are still in place. Fed rates are near zero. Banks are still Too Big To Fail — Dodd-Frank certainly didn’t end that. Very little has been fixed. In fact, the government is now attempting to use the new Consumer Financial Protection Bureau to implement the very same “easy credit” mortgage policies that got us into this mess in the first place.